HOW FOUR FIRMS GOVERN THE MONEY MARKETS AND RATTLED THE WEALTHY REICHMANNS
THE RATING GAME
HOW FOUR FIRMS GOVERN THE MONEY MARKETS AND RATTLED THE WEALTHY REICHMANNS
Although the announcements emerged quietly during the past 12 months, they had the impact of a well-timed artillery barrage. First in May, 1991, and again in August, December and in February, 1992, various credit analysts lowered their assessment of the world’s largest landlords—Toronto’s Reichmann family. Then, last month, rumors began to circulate among investors in Canada’s $30-billion market in what is called commercial paper, essentially corporate lOUs with due dates normally under 90 days, that the Reichmanns had reneged on a loan payment. The rumors were never confirmed, but investors, already skittish, reacted with something close to panic, refusing to renew almost $800 million worth of Reichmann paper. To Walter Schroeder, president of Toronto-based Dominion Bond Rating Service, that response was hard to explain. “If you view it rationally, the market overreacted remarkably,” said the man whose own increasingly cautious assessments of the Reichmanns’ debts had contributed to the alarm.
For the Reichmanns, the market’s exaggerated response posed major problems. The company this week was continuing its efforts to restructure an estimated $23-billion debt to satisfy jittery lenders. But beyond the discomfort evident in the boardroom of the Reichmanns’ holding company, Olympia & York Developments Ltd. (O&Y), the events underscored the enormous influence that Schroeder and his counterparts at three other credit-rating companies wield over corporate fortunes. Not only can their judgments make a difference of millions of dollars to a company’s borrowing costs, but, as the Reichmanns discovered, they can even threaten to tip entire empires into foreclosure. Said Anthony Walker, treasurer of Westcoast Energy Inc. in Vancouver: “Rightly or
wrongly, the credit analysts have very significant influence over a company’s cost of capital.” Credit raters have played a pivotal, if lowprofile, role in Canadian financial circles since the 1960s, when governments and corporations first began to issue short-term promissory notes as a lower-cost alternative to bank loans. Money-market lenders rely on the raters’ assessments to determine which corporations and governments are worthy of credit— and at what price. With that in mind, would-be borrowers pay fees of about $10,000 and often open their most sensitive accounts to credit analysts in an attempt to secure the most favorable rating. In turn, investors pay $2,000 a year and up to subscribe to the credit reports based on that research. And as corporations and governments increasingly borrow beyond their own borders, the analysts’ influence has steadily increased. Said
William Chambers, who analyses Canadian companies for New York City-based rating firm Standard & Poor’s Corp.: “International ratings and standards help to explain entities to investors around the world. It’s an efficient way to explain Inco to Indonesia.”
In addition to Schroeder’s Dominion Bond Rating Service and Chambers’s Standard & Poor’s, two other independent rating companies also cover Canadian markets: Montrealbased Canadian Bond Rating Service and
One of North America's largest forest products companies, MacBlo, as it is widely known, has operations in Canada and the United States. It manages 3.7 million acres of timberland, 2.5 million ofthat in British Columbia.
Assets: $3.8 billion Revenues: $2.7 billion Loss: $93.4 million ^Outstanding debt: $ 1.4 billion Commercial paper rating:
DBRS: R-2 (high)
A wholly owned subsidiary of Union Energy Inc., the company buys, distributes and sells natural gas to more than 613,000 customers in southwestern Ontario. It also stores and transports natural gas for other utilities in Ontario, Quebec and the United States.
Moody’s Investors Service of New York City. The two U.S. firms, both of which were established early in the century, each have about 1,000 analysts who rate thousands of governments and corporations worldwide. By contrast, Dominion Bond Rating Service, whose eight analysts rate 350 companies and governments, and Canadian Bond Rating Service, with 15 analysts rating 325 companies and 100 governments, are both less than 20 years old.
Without a credit rating from at least one of the four, however, borrowers face closed doors in the money market. Lenders in that market include highly conservative insurance companies, pension funds and banks, which extend money only for brief periods and rely on its safe return. As a result, lenders favor the bluest of blue-chip corporations and tolerate the barest minimum of risk. Said Brian Neysmith, Schroeder’s counterpart at Canadian Bond Rating Service: “There is no loyalty in the money market. As O&Y proved, you will be dumped in a moment.”
Even less dramatic rejections than the one directed at the Reichmanns can prove costly. A lower credit rating translates into sharply higher interest charges. The difference could be worth as much as $1,370 a day in higher interest payments on a $200-million issue of commercial debt—typical for Canadian companies. Even worse, when credit ratings sink too low, many companies find, like O&Y, that they cannot find lenders at any price.
The analysts’ judgments are well considered. Among the financial factors that raters weigh are debt-to-equity ratios and interest coverage. Those benchmarks are supplemented by assessments of a company’s position within its industry, its competition, product demand, business risk and track record. But raters studiously ignore managers who threaten and cajole in an effort to avoid negative assessments. Declared Neysmith, for one: “We sit in the middle of the devil’s triangle of debt underwriters, issuers and investors. We are professionally neutral.”
At the same time, analysts say that they do not lower a borrower’s credit rating frivolously or without warning. Indeed, before lowering a company’s rating, analysts usually warn its senior managers. The warning is intended to allow companies to retire from the commercial paper market gradually, making an orderly transition to other sources of short-term funding. Said Neysmith: “We believe it is our role to help a company to preserve its credit quality if at all possible. We even suggest what management might do to forestall a downgrade.”
For Toronto’s Reichmanns, however, any such consideration plainly came too late. Despite Schroeder’s judgment that O&Y’s debt is “manageable,” the money markets have reacted by shunning all of its short-term commercial paper. As a result, a spokesman for the company announced last week that it had retired $78 million worth of commercial paper that came due over the past two weeks, and would pay down a further $153 million coming due over the next several weeks. For the Reichmanns, the neutrality of the credit analysts clearly does not extend to the investors who rely on them.
Olympia & York is the world’s largest privately held real estate developer, with interests in more than 60 office buildings in Britain and North America.
Note: On March 18, O&Y announced that it would withdraw the two series of commercial I paper that it had issued through subsidiaries O&Y Commercial Paper II Inc. (*) and O&Y Wäter Street Finance Corp. (**).
Bell Canada, a wholly owned subsidiary of parent company BCE Inc., is Canada’s largest supplier of telecommunications services. Bell provides telephone services to nearly seven million customers in Ontario, Quebec and the Northwest Territories.
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